Holders of insured Detroit bonds should be paid in full, according to a newly released debt restructuring plan issued by Detroit Emergency Manager Kevyn Orr. Fortunately, most of Detroit’s bonds, held by individual investors, are insured.
“The Proposal For Creditors”, issued on Friday, June 14, 2013 , would significantly reduce Detroit’s debt load.
The 134 page proposal classifies Detroit’s debt into two main classes, Secured and Unsecured, depending on whether a dedicated payment stream supports the bonds.
Detroit’s Water and Sewer debt is identified as “secured” because water and sewer revenues are pledged for repayment. Because of its identified revenue stream, the proposal calls for full repayment of the system’s debt. The proposal also calls for creation of an independent regional authority to take over the Water and Sewer system, now run by the City. The Water and Sewer system currently serves 3.8 million people (one-third of the State’s population), covers 850 square miles, and 76 communities. Ratings on Water and Sewer debt are A+/Ba1, on Negative CreditWatch by both Standard & Poor’s and Moody’s.
In an unprecedented step, the proposal classifies General Obligations carrying a full faith and credit pledge, and no other dedicated payment stream, as Unsecured. These bonds are treated under the proposal at a reduced value, subject to negotiation . However, most GOs are insured as well and bondholders are expected to receive full payment. Some General Obligations carry enhancement by an intercept of State aid and are viewed in the proposal as Secured debt with full City payment promised. Standard & Poor’s and Moody’s now rate Detroit’s GOs CC/Caa2 with Negative CreditWatch.
Despite the Proposal’s unorthodox view of pledges behind the City’s bonds, bond insurance should insulate bondholders from the proposed cuts. Already, three major bond insurers (Syncora, National Public Financial Guaranty, and Assured) have affirmed their commitment and the rest are expected to follow suit. Ambac, has yet to make their plans known but recently exited bankruptcy with strong claims paying ability, and has been meeting its obligations when called upon.
The plan envisions the issuance of $2 billion of new notes to replace $11 billion of outstanding Unsecured obligations, including pension related liabilities. In many ways, the Emergency Manager’s plan is unprecedented in the world of municipal bonds, and contradicts the universal understanding of the primacy of the full faith and credit pledge recognized by investors and rating agencies alike.
The Emergency Manager intends to negotiate the terms of his proposal with employee unions, bond insurers, and other large stakeholders who stand to lose the most should the plan be ultimately adopted. If negotiations fail, Detroit will likely file for bankruptcy and let the Courts sort out the disputed claims. All of this is expected to remain outside the view of bondholders who hold insured debt. Mr. Orr’s plan is unprecedented in its scope and view of traditional practices in municipal finance. We will wait to see how successful he is in achieving implementation.